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Moody's Investors Services, a major bond rating house, warned Thursday that if bankrupt California cities don't reduce their pension obligations, they risk returning to insolvency.
The warning was aimed directly at two bankrupt cities, Stockton and San Bernardino, but Moody's cited the experience of Vallejo, which emerged from an earlier bankruptcy without reducing its pension debt and is once again facing fiscal turmoil.
"In California, particularly for municipalities with pensions under the California Public Employees Retiree System, or CalPERS, bondholders will likely continue to pay a steep price if bankruptcies remain venues for restructuring debt obligations but pension liabilities remain untouched," Moody's Vice President Gregory Lipitz said in a special report on the California situation.
Stockton did not seek to reduce its pension obligations, despite pressure from other creditors, and has nearly concluded a deal with creditors on a recovery plan.
San Bernardino is still in the mediation process with creditors, but has indicated that it may seek pension modification.
CalPERS backed Stockton's approach to bankruptcy but has been fighting San Bernardino's bankruptcy petition, contending that under California law, public employees' pensions are contracts that cannot be involuntarily "impaired."
No California bankruptcy judge has ruled on whether pensions can be altered but the judge in Detroit's multi-billion-dollar bankruptcy has said that pension obligations are debts that may be subject to modification like other debts.
"Vallejo substantially restructured its compensation structure, including significant cuts to retiree health care benefits, but by failing to address its pension liabilities it remains vulnerable to increasing annual payments," Moody's Tom Aaron, the co-author of the report, said in a statement.
Moody's warned that "Vallejo now faces the risk of a second bankruptcy if its finances continue to degrade. In its budget message the city stated it has a "well below fiscally prudent reserve level" of 5 percent of expenditures and that by (fiscal year) 2015 its budget deficit could reach $8.9 million without corrective measures."
It has been 35 years since California voters overwhelmingly approved Proposition 13, a measure that, as Gov. Jerry Brown put it in 2011, "started the centralization of power" in the state. He should know because he was also governor in 1978 and helped oversee that shift.
At the time, Californians were enraged that their inflation-fueled home values were accompanied by rising local property taxes. The referendum limited those taxes to 1% of their property's value.
Advocates of Proposition 13 claimed it would limit government spending. They were wrong. Prop 13 simply shifted revenue collection from localities — which rely on property taxes — to Sacramento, the state capital.
Taxation moved from relatively stable property taxes to erratic income taxes and regressive sales levies. By moving to income taxes that treat capital gains as ordinary income, California raises much of its revenue from a boom-or-bust system.
That's why state revenue is rising today as the stock market reaches new highs, just as revenue rose alongside robust markets in 1999 and 2007, allowing Govs. Gray Davis and Arnold Schwarzenegger to proclaim the budget balanced, just as Brown can now.
When stocks fell, however, revenue tanked. When California's economy shrank by 2.8% in 2009, revenue contracted by 10 times as much because of the larger decline in stock markets.
Those temporarily balanced budgets were followed by years of deficits and tax increases. In the absence of reform, that will inevitably happen time and time again.
The state also moved to rely more on sales taxes on goods, raising the rate by more than 60% since 1970. In parts of California, the sales-tax rate on goods exceeds 9%. This system is inherently regressive, because low-income people spend a much larger share of their incomes than wealthy people do on the consumption of taxable goods.
There is a solution. The California Legislature and Brown could adopt a sweeping tax-reform measure combined with a request to voters to repeal Proposition 13 (only the electorate has that power).
Legislators already have two tax-reform models in front of them, one from the Commission on the 21st Century Economy, and the other by the Think Long Committee for California. To varying degrees, they reduce sales- and income-tax rates, and they impose sales taxes on services and severance levies on oil and gas.
Yet neither would do anything about repealing Prop 13. That leaves untouched a significant source of stable revenue and fails to tax real estate, California's biggest industry, which, because of the state's climate and other advantages, would still attract capital, even with higher property taxes.
It's crazy to tax incomes and goods that can move to other states but be barred from raising levies on real estate and resources such as oil that can't be moved. Accordingly, no California reform would be complete without enacting a severance tax and getting rid of Proposition 13.
Repealing it might seem politically impossible. Homeowners worried about higher property taxes would have to be guaranteed a long phase-in period, low increases and meaningful cuts in sales- and income-tax rates.
Governments would first need to reduce pension and health-care liabilities because, if not, most of the new revenue raised from lifting Prop 13 would go to retired employees, instead of to current services. Of course, there would be opposition from oil and gas companies, commercial-property owners and government employees.
Overcoming their opposition would require a great politician. No one would play that role better than Brown. He has high approval ratings, and he knows he won't solve the state's core budget issues — or fulfill his dreams for high-speed rail and other legacy-building projects — unless he addresses the tax system, pensions and health care. If he seeks and wins re-election in 2014, what else could be more important?
Brown has started to move government closer to the people by devolving some functions from the state to local governments. Now he needs to devolve revenue generation as well. That would move more power to local governments and school districts.
I worry that Brown wants to run for president before the next California budget crisis rears its ugly head. Yet who else can take responsibility for creating a sustainable revenue system and establishing effective government in California?
• Crane, a former financial-services executive, is president of Govern for California, a nonpartisan government-reform group. He was an economic adviser to Gov. Schwarzenegger from 2004 to 2011.
via: investors.com
